Investing in Mutual Funds

BY William Brister

Mutual fund investment is one of the most popular means of investment today. The Securities and Exchange Commission (SEC) has defined a mutual fund as "a company that brings together money from many people and invests it in stocks, bonds or other assets." What it means is that when you buy a mutual fund, you are essentially buying a small part of the fund; you do not actually own any of the assets the mutual fund owns. However, these assets are still very important because the value of the fund depends on the value of the assets it holds. The value of the mutual fund rises or falls in proportion to the increase or decreases in the value of the stocks and bonds it holds.

Advantages of investing in top mutual funds
There are two primary benefits of investing in mutual funds:

Diversification - When investing in mutual funds your assets are diversified; by virtue of each fund owning multiple stocks and bonds, you are essentially buying a piece of every asset held and owning many different assets at one time.
Professionally Managed - Mutual Funds are typically under the management of professional market analysts with a good knowledge of the markets. Thus investing in mutual funds takes the time, pressure and effort off your mind.
Different kinds of Mutual Funds
There are typically two types of mutual funds:

Closed Ended - Theses have a certain restricted number of shares. If you want to purchase a piece of the fund, you have to purchase an existing share.

Open Ended - These have an unlimited number of shares and if you want to purchase a piece of the fund, the fund creates a new share and sells it to you.

Analyzing the performance of the top mutual funds
It is natural for investors investing in mutual funds to not only see the rate of return on their mutual funds but also compare the performance of different mutual funds in the same sector. An investor will find the performance rating of individual mutual funds in newspapers or related journals whereas the MorningStar Ratings and the Lipper Ratings will give a comparative analysis of different and top mutual funds. The SEC requires mutual funds to furnish historical returns since the time of their inception to about ten years. The past record is a distinct indicator of how well or badly the fund is performing.

While Morningstar rates funds using a "star" system--with 5 stars being the highest rating and 1 star being the lowest rating, Lipper rates funds using a numeric score--with a "1" being the highest rating and a "5" being the lowest rating.

Expenses of a mutual fund:
While it is obvious that all mutual funds will have expenses, it is essential to be aware of a fund's expenses before you invest in it as they can have a major influence on your investment returns. The main expenses that you should be aware of primarily are:

Loads - These are fees loaded on to you when you either buy or sell as mutual fund and are usually used to pay a commission to the agent who sold you the fund. The front-end loads when you buy a mutual fund cannot exceed 8.5%25. Very few companies forgo this fee.

Redemption fees - This is a provisional fee that is slapped on you in the event that you sell off the mutual fund before a certain date. This fee is intended to prevent turnover in the fund.

Operating expenses comprise of management fees and 12(b)-1 fees and indicate the operating expense ratio. These fees are charged as a normal part of doing business for the fund. Management fees go to pay the fund manager for his expertise and time while 12(b)-1 fees cover advertising and distribution expenses for the fund.

Prospectus of a Mutual Fund
The fund's prospectus informs you in detail everything you want to know about the fund. It includes the fund's objectives, past performance, about the fund manager and all associated fees. The prospectus will also contain any contact information if you need to verify or satisfy your queries further.

Buying Mutual Funds
Investing in mutual funds can be done through a broker, personal IRA accounts or even a company sponsored 401(k) plan. However, it is essential to note that mutual funds do not trade like stocks and shares and cannot be bought or sold during market hours. The buying and selling of mutual funds can only take place at the end of the day. This is so because, mutual funds are traded based on their Net Asset Value (NAV), which is essentially determined at the end of trading day. The mutual fund company evaluates all the assets that it has in its fund, determines their value and divides that number by the total number of outstanding shares in the fund. This is a complex process and the fund company will go through it once a day once the market closes. In order to combat this inflexibility, mutual funds also allow you to purchase fractional shares of a mutual fund.

William Brister - http://www.moneyproguide.com - The most popular means of investing.

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